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The Credit Risk Iceberg: Part 3: Private Companies

Thomas Yagel

In Part 1 and Part 2 of this series we introduced the concept of the Credit Risk Iceberg and discussed how public companies fit into it. In this post, we dig into availability of private company data and private company credit analytics.

Most of the iceberg, and subsequently, the full universe of counterparties, lie in the murky depths where you have to make do with much less detail. This is the private company universe which numbers in the hundreds of millions globally. For these companies, obtaining more than cursory information can be a challenge.

Industry regulatory bodies (e.g. insurance company regulators) require that a small subset of private companies file financials regularly. In some regions, filings must be made publicly available through annual tax returns, depending on local laws. Another small subset of private companies is required to file financials that are publicly available because they have capital markets debt (private companies with public debt).

Brazil is one example of how challenging getting private company data can be. In Brazil, private companies are now required to file financial statements annually in regional newspapers. Clearly, for the individual looking to understand a specific set of private Brazilian counterparties, rounding up the correct issue of some set of different print publications is likely unfeasible. That problem compounds itself when you start to look to compile historical data.

S&P Capital IQ has helped to solve this particular challenge in Brazil by partnering with a local company (KLOOKS) to pull all the available data on a universe of 10,000 companies. In fact, we undertook a comprehensive analysis using this data on the economic health of Brazil by taking a financials assessment of public and private companies in the country. The main finding of that analysis was that private companies in Brazil had valuation multiples based on their financials, which seems to indicate future investment opportunities. Click here to read the full paper.

In many cases, however, the only way you can get financials for your private counterparties is directly from the counterparty itself. The depths of the iceberg don’t yield their secrets easily. Even when you can obtain private company data, there are still challenges. The data must be normalized so that it is easily comparable to other companies and sufficient for use in quantitative credit models. If the data comes from your counterparties directly, you may be left needing a way to manage and store the financial information in a scalable framework.

Once the myriad private company data challenges have been addressed you can finally get a better picture on the credit quality of your private counterparties by applying that data to a fundamentals based probability of default model. Hopefully you will be able to avoid an underwater brush with the depths of the iceberg that leaves your ship floundering like the Titanic.